Consider the fed funds rate when prior to any changes in the discount rate, banks just...

Consider the fed funds rate when prior to any changes in the discount rate, banks just borrow from the Federal Reserve System, but not from other banks (Federal funds rate = Discount rate). What happens to the fed funds rate when discount rates are lowered? Draw the graph and explain what happens to the federal funds rate.

Expert Solution

Federal Fund Rate

It is the interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis. The law requires banks to keep a certain percentage of their customer's money on reserve, where the banks earn no interest on it. The Federal reserves requires banks and other financial institutions to hold a certain amount of money in reserves at the end of each business day to ensure customers can access theri funds and toprotect against bank failures. This is referred to as the reserve requirement. The reserve requirement is approximately 10% of the deposits made at a financial institution.

The FOMC (Federal Open Market Commitee), the monetary policy making body of the Federal Reserve System. It makes the decision about rate adjustments based on inflation, recession, or other issues.

Besides the Federal funds Rate, the Federal reserve also sets a discount rate, which is the interest rate the Fed charges banks that borrow from it directly. Expansionary monetary policy is used to stimulate the growth. In this policy the bank have to lower their interest rates to compete. It increases the money supply, spurs lending, and boosts economic growth.

This situation was happened in 1992 to 2004.

The line centered on zero in the chart is the difference between the two interest rates; it is calculated as the fed funds rate less the discount rates. Before 2003, the line showing the difference between the two interest rates indicates that the funds rate typically was above the discount rate by a small margin. However, since the change to a "penalty" discount rate policy in 2003, the funds rate has been consistently below the discount rate.

Rahul Sunny answered 2 years ago

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Consider the fed funds rate when prior to any changes in the discount rate, banks just...

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